Bonus share: Explained | TIOmarkets
BY TIO Staff
|July 1, 2024In the world of trading, there are many terms and concepts that traders need to understand to navigate the market effectively. One such term is 'bonus share'. A bonus share, also known as a scrip issue or capitalization issue, is a free share of stock given to existing shareholders in a company, based upon the number of shares that the shareholder already owns. These shares are typically funded by the company's retained earnings.
The issuance of bonus shares is a common practice among companies, particularly those in the growth phase of their business cycle. It is a strategy used to reward shareholders without reducing the company's cash reserves. This article aims to provide a comprehensive understanding of the concept of bonus shares, its implications, benefits, drawbacks, and its role in trading.
Understanding Bonus Shares
Bonus shares are additional shares given to the current shareholders without any additional cost, based upon the number of shares that the shareholder owns. These are company's accumulated earnings which are not given out in the form of dividends, but are converted into free shares. The main aim of issuing bonus shares is to encourage retail participation by increasing the number of shares.
When a company issues bonus shares, the total number of shares owned by each shareholder increases, but the value of each share decreases. However, the total value of the shares remains the same. This is because the issuance of bonus shares does not increase the company's assets or its profits.
The Process of Issuing Bonus Shares
The process of issuing bonus shares involves several steps. First, the company's board of directors must propose the issuance of bonus shares. This proposal is then put to a vote at the company's annual general meeting. If the proposal is approved, the company will then determine the ratio of bonus shares to be issued for each existing share.
Once the ratio is determined, the company will issue the bonus shares to the existing shareholders. The shareholders will then have the option to sell these shares on the open market, or they can choose to hold onto them. The issuance of bonus shares increases the company's share capital but does not affect its net assets.
Implications of Bonus Shares
The issuance of bonus shares has several implications for both the company and its shareholders. For the company, issuing bonus shares can help to increase the company's share capital without affecting its net assets. This can be beneficial for companies that are looking to expand or invest in new projects.
For shareholders, bonus shares can provide an immediate increase in the number of shares they own, which can increase their voting power in the company. Additionally, if the company's profits increase, shareholders may also benefit from increased dividend payments.
Benefits of Bonus Shares
There are several benefits associated with the issuance of bonus shares. One of the main benefits is that it increases liquidity in the market. This is because the number of shares available for trading increases, which can make it easier for investors to buy and sell shares.
Another benefit of bonus shares is that they can help to reduce the share price, making the shares more affordable for small investors. This can encourage more people to invest in the company, which can increase the company's market capitalization.
Increased Liquidity
One of the main benefits of bonus shares is that they increase liquidity in the market. When a company issues bonus shares, the number of shares available for trading increases. This can make it easier for investors to buy and sell shares, which can increase trading activity and liquidity in the market.
Liquidity is a key factor for traders as it allows them to enter and exit positions easily. With more shares in circulation, traders can execute their trades more efficiently, which can lead to better trading outcomes.
Reduced Share Price
Another benefit of bonus shares is that they can help to reduce the share price. When a company issues bonus shares, the total number of shares increases, but the value of each share decreases. This can make the shares more affordable for small investors, which can encourage more people to invest in the company.
By reducing the share price, bonus shares can help to increase the company's market capitalization. This can be beneficial for the company as it can increase its visibility in the market and attract more investors.
Drawbacks of Bonus Shares
While there are several benefits associated with bonus shares, there are also some drawbacks. One of the main drawbacks is that the issuance of bonus shares can dilute the earnings per share (EPS). This is because the total number of shares increases, but the company's earnings remain the same.
Another drawback of bonus shares is that they can lead to a temporary drop in the company's share price. This is because the market may perceive the issuance of bonus shares as a sign that the company is not able to pay dividends in cash.
Dilution of Earnings Per Share
One of the main drawbacks of bonus shares is that they can dilute the earnings per share (EPS). EPS is a key financial metric that investors use to assess a company's profitability. It is calculated by dividing the company's net income by the total number of outstanding shares.
When a company issues bonus shares, the total number of shares increases, but the company's net income remains the same. This means that the EPS will decrease, which can make the company appear less profitable than it actually is. This can potentially impact the company's share price and its attractiveness to investors.
Temporary Drop in Share Price
Another drawback of bonus shares is that they can lead to a temporary drop in the company's share price. This is because the market may perceive the issuance of bonus shares as a sign that the company is not able to pay dividends in cash. This can lead to a sell-off in the market, which can cause the share price to drop.
However, this drop in share price is usually temporary. Once the market adjusts to the new number of shares, the share price will typically stabilize. Therefore, while the issuance of bonus shares can lead to a temporary drop in share price, it does not necessarily indicate a long-term decline in the company's value.
Bonus Shares in Trading
In the world of trading, bonus shares can have significant implications. Traders need to be aware of the potential benefits and drawbacks of bonus shares, and how they can impact the market. Understanding the concept of bonus shares can help traders to make more informed decisions and to navigate the market more effectively.
When a company announces that it will be issuing bonus shares, this can lead to increased trading activity. Traders may choose to buy shares in anticipation of the bonus issue, in the hope that the share price will increase. Alternatively, traders may choose to sell their shares if they believe that the bonus issue will lead to a drop in the share price.
Trading Strategies
There are several trading strategies that traders can use when a company announces a bonus issue. One strategy is to buy shares in anticipation of the bonus issue. This is based on the expectation that the share price will increase as a result of the bonus issue.
Another strategy is to sell shares in anticipation of the bonus issue. This is based on the expectation that the share price will drop as a result of the bonus issue. The choice of strategy will depend on the trader's assessment of the market conditions and their expectations for the company's future performance.
Impact on Market
The issuance of bonus shares can have a significant impact on the market. It can lead to increased trading activity, as traders buy and sell shares in response to the bonus issue. This can increase liquidity in the market, which can benefit all market participants.
However, the issuance of bonus shares can also lead to volatility in the market. This is because the market needs to adjust to the new number of shares and the reduced share price. Traders need to be aware of this potential volatility and be prepared to manage their risk accordingly.
Conclusion
In conclusion, bonus shares are a key concept in trading that traders need to understand. They are additional shares issued by a company to its existing shareholders, funded by the company's retained earnings. The issuance of bonus shares can have significant implications for both the company and its shareholders, and can impact the market in various ways.
While there are several benefits associated with bonus shares, such as increased liquidity and reduced share price, there are also some drawbacks, such as dilution of earnings per share and a temporary drop in share price. Traders need to be aware of these potential benefits and drawbacks, and how they can impact their trading strategies.
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